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RUHRECONOMIC PAPERS
Fostering Green Investments and Tackling Climate-Related Financial Risks: Which Role for Macroprudential Policies?
#778
Paola D‘OrazioLilit Popoyan
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ISSN 1864-4872 (online) – ISBN 978-3-86788-906-3The working papers published in the series constitute work in progress circulated to stimulate discussion and critical comments. Views expressed represent exclusively the authors’ own opinions and do not necessarily reflect those of the editors.
Ruhr Economic Papers #778
Paola D‘ Orazio and Lilit Popoyan
Fostering Green Investments and TacklingClimate-Related Financial Risks: Which
Role for Macroprudential Policies?
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http://dx.doi.org/10.4419/86788906ISSN 1864-4872 (online)ISBN 978-3-86788-906-3
Paola D‘Orazio and Lilit Popoyan1
Fostering Green Investments and Tackling Climate-Related Financial Risks: Which Role for Macroprudential Policies? AbstractWhile there is a growing debate among researchers and practitioners on the possiblerole of central banks and financial regulators in supporting a smooth transition toa low-carbon economy, the information on which macroprudential instruments couldbe used for reaching the “green structural change” is still quite limited. Moreover,the achievement of climate goals is still affected by the so-called “green finance gap”.The paper addresses these issues by proposing a critical review of existing and novelprudential approaches to incentivizing the decarbonization of banks’ balance sheetsand align finance with sustainable growth and development objectives. The analysiscarried out in the paper allows understanding under which conditions macroprudentialpolicy could tackle climate change and promote green lending, while containingclimate-related financial risks.
JEL Classification: E50, E52, G28, Q50, Q58
Keywords: Climate Change; climate finance gap; banking regulation; macroprudential policy; central banking; climate-finance risk
November 2018
1 Paola D’Orazio RUB; Lilit Popoyan, Scuola Superiore Sant’Anna, Italy. – All correspondence to: Paola D’Orazio, Ruhr-Universität Bochum, Lehrstuhl für Makroökonomik, Faculty of Economics and Management, Fakultät für Wirtschaftswissenschaft, Universitätsstr. 150, 44801 Bochum, Germany, e-mail: [email protected]
1 Introduction
There is now widespread recognition of climate change (Oreskes, 2004; Doran and Zim-
merman, 2009; Cook et al., 2013). As pointed out by Rockstrom et al. (2009), three of
nine interlinked planetary boundaries have already been overstepped and the ecosystem
is heading toward a tipping point that poses an existential risk to society (Friedlingstein
et al., 2014). To enhance a so-called green structural change, considerable investments are
required in the sectors characterized by high capital costs, i.e., the building, industrial,
transport and energy sectors (WEF, 2013), as shown in Figure 1. Additionally, considering
green energy efficiency, it has been estimated that an eight-fold increase in annual invest-
ments is needed by 2035, while investments in the so-called low-carbon power generation
(including renewable energy, nuclear energy, and carbon capture and storage) will need a
three-fold increase, in order to be aligned with a green transition scenario (OECD/IEA,
2014).
The evidence for the “green finance gap”, i.e. the lack of sufficient financial resources
to be directed towards green investments (Buchner et al., 2017), is particularly relevant for
the transition towards a low-carbon economy, because it represents a serious hindrance for
the achievement of the climate goals as discussed during the COP-UNFCCC (Conference
of the Parties to the United Nations Framework Convention on Climate Change) (COP,
2015, 2016) and for an adequate technological progress (D’Orazio and Valente, 2018) that
could prevent a so-called soft landing (Schoenmaker and Van Tilburg, 2016). However, the
required investments are difficult to be met under the current financial framework (Maz-
zucato, 2013; Mazzucato and Semieniuk, 2018). A growing body of evidence suggests that
investment processes, accounting frameworks, and financial regulatory regimes contain an
intrinsic “carbon bias” that creates barriers to aligning the finance sector with sustain-
able transition roadmaps (see Campiglio, 2016; Volz, 2017, among others). Moreover, at
the current stance, the financial portfolios that are highly exposed to carbon-intensive
“stranded” assets (Caldecott and McDaniels, 2014; Battiston et al., 2017) imply a po-
tential threat for the soft landing scenario (Schoenmaker and Van Tilburg, 2016) and
have implications for systemic risk (Gros et al., 2016). Some analysts have argued that
macroprudential initiatives following the financial crisis, notably Basel III, seem to pro-
mote short-term “brown” investments at the expense of more long-term, climate-friendly
investments (Gersbach and Rochet, 2012; Haldane, 2013; Thanassoulis, 2014), and the
liquidity requirements in particular, might negatively affect banks’ willingness to lend to
green projects (Liebreich and McCrone, 2013; Narbel, 2013; Spencer and Stevenson, 2013;
Caldecott and McDaniels, 2014). Additionally, it has been noted that although the nowa-
days financial regulatory framework made notable progress to detect, assess and contain
systemic risks (BCBS, 2011), it still overlooks the possibility that systemic risk arises in
case of a “green transition”.
1
Figure 1: Annual estimated investments needed by sector in two different scenarios: Business-as-Usual (BaU) left bar, Low-carbon economy (LC) right bar. Data in billion US$2010 rates. Thereported estimates show that to make the so-called low-carbon scenario effective, $14 trillion areneeded over the period of 2010-2030; the annual average investment in green technologies in allthe sectors considered in the study, should be on average $0.7 trillion.Source: authors’ elaboration based on data presented in WEF (2013). We refer the reader to theWEF (2013, Appendix 1) for more details on the methods used to gather and process the data.
Nowadays, climate-related financial risks are highly debated because of the possible
effects of these risks for the financial system, and financial stability in general (see Carney,
2015; Dietz et al., 2016; Battiston et al., 2017; Monasterolo et al., 2017; Volz, 2017, among
others). Three different types of risk have been identified (Carney, 2015). Transition
risks are those that could arise from a sudden and disorderly transition to a low-carbon
economy. Physical risks are “those risks that arise from the interaction of climate-related
hazards (including hazardous events and trends) with the vulnerability of exposure of
human and natural systems” (Batten et al., 2016). Liability risks stem from “parties who
have suffered loss from the effects of climate change seeking compensation from those they
hold responsible” (Carney, 2018, p.2). Nevertheless, central banks and regulators, with few
exceptions (Batten et al., 2016; Carney, 2018; Dikau and Ryan-Collins, 2017; Campiglio
et al., 2018), seem to overlook climate objectives in practice (Monnin, 2018). A possible
explanation for this neglect is related to the models traditionally used by central banks,
which “are not well suited to capturing the effects of climate change or the complexity of
the economic transition” (Sevillano and Gonzalez, 2018, p.129). Indeed, only recently a
2
new generation of models has been developed to account for the effects of climate change on
financial and economic stability (Balint et al., 2017; Fontana and Sawyer, 2016; Dafermos
et al., 2017, 2018; Monasterolo and Raberto, 2018; Bovari et al., 2018; Lamperti et al.,
2018).
Despite the rising awareness of the adverse impact of climate-related risk on financial
stability (Carney, 2015; HLEG, 2018; DNB, 2017), there are no internationally agreed-
upon regulatory schemes to withstand the potential losses they can cause to the financial
sector. To tackle climate-related financial issues, the attention of researchers has been so
far devoted mainly to the possible effects of the transition process on the financial sector
(Carney, 2015; Covington and Thamotheram, 2015; Campiglio et al., 2017; Bovari et al.,
2018) and market-based measures have been proposed to solve the issue (Stiglitz et al.,
2017). However, carbon taxes, as well as policies based on subsidies, seem to reflect a
lack of awareness of the financial risks related to climate change (World Bank, 2014, 2016;
Campiglio, 2016), such as the loss of value of financial assets (Dietz et al., 2016), or the
issue of stranded assets (Caldecott, 2017; Delis et al., 2018).
Taking into account the current policy framework and the climate-related financial
risks, the paper takes a different perspective, and aims to investigate the possible effects
of financial regulation, as well as the transition process towards a green economy. In our
analysis, we focus in particular on the extent to which a prudential regulation, explicitly
aimed at promoting a green economic transition, is a tool policymakers could and should
use to foster green investments and mitigate climate-related financial risk (Carney, 2015;
Gros et al., 2016; Draghi, 2017). We show these interlinkages in Figure 2.
A number of research works have been studying possible modifications of standard
central banking to include instruments to support the green transition, considering for
example green bonds or green quantitative easing (Batten et al., 2016; Matikainen et al.,
2017; Volz, 2017; Campiglio et al., 2018). In our paper, instead, we shed light on the regu-
latory instruments that can be implemented within the existing regulatory framework. In
particular, we focus on the following research questions: Is the current macroprudential
regulatory framework “green enough” to enhance both a low-carbon transition and finan-
cial stability?; If not, how policymakers can make it “greener” and what are the possible
(unintended) consequences the existing regulatory framework can have on the transition?
We consider these questions of particularly relevance because, as pointed out by Carney
(2015), the “green transformation” of the global economy may occur paired with high
market volatility and disturbances in capital flows, causing systemic risks for the financial
sector.
The contribution of the research carried out in the paper is twofold. First, a critical
review of existing and novel prudential approaches to align finance with sustainable growth
and development objectives, as well as incentivize the “decarbonization” of banks’ balance
sheets, is presented. Second, by reviewing official central banks documents, it provides an
3
Prudential regulation
Physical risks
Financial flows Transition risks
Short-term interest rate
HIGH-CARBON ECONOMY LOW-CARBON ECONOMY
Prudential policy
Monetary policy
BROWN GREEN
REAL ECONOMY
FINANCIAL SECTOR
brown loans
green loans
reserves equity
deposits
ASSETS LIABILITIES
Liability risksFinancial flows
green loans
brown loans
reserves equity
deposits
otherliabilities
ASSETS LIABILITIES
otherliabilities
Figure 2: The interaction between the real and financial sectors, accounting for monetary andmacroprudential policies interventions, in case of the low-carbon transition process.
up-to-date mapping of green prudential regulations and tools at the OECD and European
level.
The remainder of the paper is organized as follows. Section 2 introduces the topic of
financial regulation aimed at tackling climate change, by presenting the state-of-the-art
in the existing regulatory framework. Section 3 discusses possible extensions of exist-
ing prudential regulations explicitly aimed at affecting credit allocation, fostering green
investments, and tackle climate-related financial risks. A review of the available green
macroprudential tools is presented, along with an analysis of their pros&cons. Finally,
Section 4 concludes.
4
2 Financial regulation and climate change
Financial stability has been particularly relevant in the last decades, when policymakers
from emerging to advanced economies have been working to implement macroprudential
policy tools (see Kahou and Lehar, 2017; Galati and Moessner, 2017, for recent reviews
on macroprudential policies)1. The introduction of financial regulation as a new “policy
mandate” for central bankers has been accelerated by the 2007-2008 financial crisis. By
echoing the Financial Stability Hypothesis (Minsky, 1992), the financial crisis raised the
awareness that it is important to catch the early-warning signals of crises and address,
already in “normal times”, the potential risks that could affect the financial system. One of
the key lessons of the financial crisis has been indeed that “[. . . ] stability is destabilizing”
(Minsky, 1982, p.101) and that price stability can coincide with the build-up of excessive
financial risk.
In addressing the concerns raised by the financial crisis, the regulators decided to im-
prove the existing international financial framework by going beyond the so-called Basel
II approach, which was concerned with the safety and soundness of individual financial
institutions2. The post-crisis “new normal”, instead, has been featured by a macropru-
dential framework, namely Basel III, that explicitly tackles systemic risks thereby limiting
the incidence of disruptions in the provision of key financial services that can have se-
rious consequences for the real economy. However, under the existing Basel III accord,
climate-related financial risks are narrowly defined, and regulatory capital and liquid-
ity regulations3 (under Pillar 1) do not explicitly require banks to assess the impact of
climate-related risks (CRRs) on bank’s exposures (BCBS, 2016; ESRB, 2016a). Moreover,
it reinforces short-termism4 in financial markets (Haldane, 2011), hence creating obsta-
1 There exist different policy frameworks and types of mandates for central banks, depending on whethermonetary policy and macroprudential policy are conducted “under the same roof”, whether financialstability is considered as a secondary objective for monetary policy, or if the two are considered to beconducted independently by two different authorities/institutions (see Smets et al., 2014, for a theoreticaldiscussion about these issues). In particular, in the last decade, the matter on whether monetary policyshould include financial stability objectives has been highly debated (see Angelini et al., 2012; Mishkin,2017, among others) and it has been documented that the pervasiveness of the interaction among the “twospheres” changes especially in time of crises (Smets et al., 2014).
2With term “Basel”, we refer to the so-called Basel Accords, which are banking regulation agreementsrelated to capital, market and operational risks, issued by the Basel Committee on Banking Supervision(Switzerland) (see Borio, 2003, 2014, among others). By now, there are three accords published, each oneimproving upon the previous; namely, Basel I, Basel II, Basel III. In the paper, we refer mostly to BaselII and III. For a comparison between the two frameworks, we refer the reader to Table 3 reported in theAppendix A.
3Capital requirements are set by regulatory agencies, such as the Bank for International Settlements,for banks and other depository institutions to determine how much liquidity is required to be held for acertain level of assets. These requirements are set to ensure that banks and depository institutions are notholding investments that increase the risk of default and ensure that they have enough capital to operateand allow for deposit withdrawals. The objective of liquidity requirements is to promote the short- andlong-term resilience of the liquidity risk profile of banks imposing to hold an adequate level of liquid assetsagainst their liabilities.2
4In the paper, we adopt the following definitions: a short-term financial instrument is one that has 1
5
cles for capital mobilization aimed at green investment projects (King, 2013; Spencer and
Stevenson, 2013; Bhattacharya et al., 2015), which require long-term “patient” financial
capitals that are, by definition, riskier than short-term assets (Dore, 2008; Mazzucato,
2013).
GREEN BASEL III
Pillar I Pillar II Pillar IIIEnhanced capital & liquidity Enhanced supervisory review Enhanced risk disclosurerequirements & market discipline
- Liquidity coverage ratio (LCR) - Internal capital adequacy - Regulatory capital components- Net Stable Funding Ratio (NSFR) assessment process (ICAAP) - Regulatory capital ratios- Leverage ratio - Supervisory review - Securitisation exposures- Capital conservation buffers Evaluation process - Enhanced disclosure- Countercyclical capital buffers - Stress tests * (qualitative disclosure)- Enhanced loss absorption clause - Climate-related stress tests * (quantitative disclosure)- Securitization- Trading risk- Counterparty credit risk
Table 1: The enhanced Basel III framework considering climate-related financial risk concerns.Instruments discussed in the paper are in italics.
The decision about whether to incorporate a “green objective” in the mandate of
central banks and/or regulatory authorities, depending on the country and related insti-
tutional frameworks, has been highly debated in recent years (Schotten et al., 2016; DNB,
2017; HLEG, 2018). In our view, considering the negative externalities deriving from
climate-related financial risks, regulatory authorities can suggest measures that could al-
low banks to increase long term lending, without harming the financial system’s stability.
If one adopts this perspective, macroprudential policy enriched with the “greened” tools,
should be concerned with financial stability and a climate-related objective, hence reaching
also the objective of aligning finance with sustainable growth and development. Bearing
these caveats in mind, we suggest the implementation of a set of regulatory tools that we
present and discuss in Section 3. As showed in Table 1, we focus mostly on lender-based
measures5 that are already defined under Pillar I6, by emphasizing the “green potential”
they entail. Indeed, we point out that the existing capital requirements could make banks
more hesitant towards green lending, and liquidity requirements could penalize long-term
loans (Blundell-Wignall and Atkinson, 2010; Allen et al., 2012; Angelini et al., 2015). It is
thus important to change their impact in order to achieve the above-discussed objectives.
Regarding Pillar II, we maintain that it should be extended to include CRRs, and that
to 3 years of maturity; a long-term asset is one that is characterized by more than 7 years of maturity.5While the restriction on lenders influence the supply side of credit, measures like the release of loan-to-
value (LTVs), loan-to-income (LTIs), and debt-to-income (DTIs) influences the demand for credit (Ducaet al., 2018). Generally, the application LTV and DTI caps set a limit on the amount of lending to aparticular customer based on the value of the asset is obtained (e.g., mortgage) or impose restrictionsdepending on the income of borrowers. In this way, they boost the resilience of the banking sector directlyby dropping the probability of default and loans’ loss-given-default. These measures could be used in thegreen transition to limit lending to targeted companies or sectors which are primarily involved carbon-intensive activities.
6The term “Pillar” refers to the areas of focus of the Basel’s accords.
6
the identification of early warning risk indicators is fundamental in the macroprudential
policy setting process. In this respect, climate-related stress tests (CRSTs) are of vital
importance to assess the extent to which financial institutions are exposed to carbon-
intensive assets (Kelly and Reynolds, 2016; Thoma and Chenet, 2016; Battiston et al.,
2017; Monasterolo et al., 2017). A CRST aims at evaluating the resilience of the financial
system to adverse climate shocks. It does so by analyzing the possible impact of hypo-
thetical climate-related shock scenarios on the stability of individual financial institutions
and the financial system in its complexity. Despite raising awareness about the CRRs and
exposures, developing a robust stress test is a very important first step to calibrate and
evaluate green macroprudential tools. Indeed, information filtered from the stress tests
could be used to define minimum capital standards, risk weights, credit caps and floors for
a particular type of asset (see Section 3). Regarding Pillar III, we claim that disclosure
requirements, both quantitative and qualitative, should be included so that investors can
fully learn the risks to which specific banking institutions are exposed. Similar propos-
als regarding the enhancement of Pillars II and III have been discussed by the European
Systemic Risk Board (ESRB)7, according to which, in the short-term, disclosure should
be enhanced to include CRRs in regular stress tests, while carbon stress tests are more
appropriate for the medium/long-term (ESRB, 2016b). An analogous view has been ex-
pressed by the EBF (2018); it emphasizes, however, also the crucial importance of the
establishment of a common taxonomy and disclosure framework before any modification
of the existing regulation. We deem the last point of particular importance as the extent
to which a financial asset can be considered “green” plays a crucial role in the defini-
tion of a bank’s portfolio. To the best of our knowledge, there is no commonly defined
taxonomy nor an agreed-upon disclosure framework, as advocated by the Financial Stabil-
ity Board-Task Force on Climate-related Financial Disclosures (TCFD, 2017). However,
some progresses in this direction have been made in the past months. For example, in
May 2018, the EU Commission set up a Technical Working Group on Sustainable Finance,
whose main tasks are to assist the Commission in the development of (1) an EU taxonomy
of environmentally sustainable economic activities; (2) an EU Green Bond Standard; (3)
a category of “low carbon” indices for use by asset and portfolio managers as a bench-
mark for a low carbon investment strategy; (4) metrics allowing improving disclosure on
climate-related information. Although an appropriate and widely agreed-upon metric of
“greenness” is difficult to achieve, for the sake of clarity of the analysis carried out in
the paper, we suggest a possible definition of the “green” attribute to be attached to any
financial asset that meets the requirement; we use the following definition throughout the
paper. In our view, a green asset is one related to the financing of a green investment,
7For discussions about “green-related” measures under Pillar II and III, we refer the reader to ESRB(2016b); Battiston et al. (2017); Monasterolo et al. (2017); Stolbova et al. (2018); EBF (2018), and thereferences therein.
7
which is in turn defined as a project aimed at energy efficiency, renewable energy develop-
ment, sustainable water management, clean transport systems development, sustainable
agriculture, pollution prevention, climate change adaptation. In this context, any social
aspect, although important, is not considered for this definition of “green”. Alternative
measures of “green” could be the environmental risk classification computed by Moody’s
(2018), a low value resulting from a CRSTs, or a labelling scheme as the one developed for
green bonds (see Ehlers and Packer, 2017). Regarding the definition of brown, as pointed
out by UN-Environment and World Bank (2017), “[a]lthough a formal definition of brown
assets does not exist, existing initiatives associate them with the financing of emission-
incentive activities (for example, oil and gas)” (UN-Environment and World Bank, 2017,
p.42). In our paper, we share this interpretation. However, as emphasized by HLEG
(2018), additional research is needed to enhance the development of a common defined
taxonomy of “green”, “brown” and “neutral” assets8.
Figure 3: The diffusion of green prudential requirements; year: 2018 (last update: October).Source: Authors’ elaboration based on the ”Green Macroprudential Index” computed accordingto the data contained in (D’Orazio and Popoyan, 2018).
Before looking at the prudential tools in details, we consider countries’ experiences
in the development and adoption of green regulations. Figure 3 offers an overview (as of
March 2018) of the state-of-the-art climate-related regulations. We distinguish among four
categories: countries that adopted a mandatory regulation (described in green), countries
that developed a voluntary regulation (described in yellow), countries that have both
mandatory and voluntary regulations (described in grey), and finally countries which are
8An interesting implementation of these concepts has been proposed by Kemp-Benedict (2018) in atheoretical model that studies the interactions between investments and macro dynamics.
8
discussing the possibility to introduce such regulations (described in blue). From this
analysis, several interesting conclusions can be drawn. First, a clearly defined cluster
of emerging economies located in the East Asia region (namely; China, India, Pakistan,
Bangladesh, Vietnam, Indonesia) appears as the leader of the adopters of mandatory
regulations. Other examples are Nigeria and Brazil, for which we report the adoption of
both mandatory and voluntary regulations. Second, European countries, as well as other
high-income countries emerge instead as the “laggards”, because, except from France9,
the adoption of a climate-related perspective in the financial regulation is still a topic
of discussion at the policy level (HLEG, 2018). In line with previous existing analyses
(Alexander, 2014; Dikau and Ryan-Collins, 2017), it is therefore evident that low income
countries and emerging economies are the most engaged in pursuing policies aimed at
greening the banking sector. The rationale behind this evidence is twofold. First, central
banks in emerging and low-income countries have a larger spectrum of goals (and functions)
than their high-income countries counterparts. Indeed, policy objectives usually explicitly
include output growth, exchange rate stability and macroprudential supervision (Hahm
et al., 2012; Ghosh et al., 2016; Chen et al., 2017). Second, low-income countries are more
exposed to climate change; therefore they have to craft a response that needs to be more
timely and effective in the very short run.
3 Green macroprudential tools: challenges and implications
In this section, we analyze the ongoing debate and discuss possible novel tools aimed at
supporting the low-carbon transition while keeping the financial system “safe and sound”.
Additionally, we propose a classification of macroprudential tools (see Claessens, 2014;
Cerutti et al., 2017, for more insights of the classification approaches of macroprudential
instruments), as shown in Table 2. Furthermore, we discuss the challenges and implications
deriving from their possible enforcement; we summarize the results of our analysis in
Table 6 while additional details on the countries’ implementation, policy’s objective/s
and juridical frameworks are available in (D’Orazio and Popoyan, 2018). We additionally
provide an overview of the diffusion of specific prudential instruments in Figure 4. From
the inspection of this figure, we notice that no capital instruments have been implemented
yet. The most diffused instrument are mostly lending limits, which are mandatory in
Bangladesh, India, Nigeria, Brazil, Laos, South Korea, Vietnam and are in the policy
agenda discussion in Denmark, Ecuador, Japan, Kenya. Regarding measures related to
Pillar II, we observe that climate-related stress tests have been so far implemented only
in China, and are under discussion in France and the Netherlands. Finally, risk disclosure
9 In 2013, the country set up an “Action plan for EU strategy” put forward by the Ministry of Ecologyin order to embed social responsibility and responsible finance in the private and public sector as well asin the financial sector.
9
and risk assessment defined under Pillar III, are gathering a lot of interest in countries
such as Colombia, Indonesia, Pakistan, Peru, South Africa, Switzerland, Turkey. For a
more detailed overview on the European and Asian areas, we point the reader to Appendix
B and C, respectively.
Intermediate Objective Category Instrument
Limit misaligned incentives, canalize Reserves • Differentiated reserve requirementcredit to green sectors Reserves of exposure
Mitigate and prevent excessive credit Capital • CAR with GSFgrowth and leverage Capital • Countrecylical capital buffer
Capital • Sectoral leverage ratio
Limit the concentration of certain Lending limits • Max(min) credit ceiling (floor)exposures Lending limits • Large exposures limit
Mitigate and prevent market illiquidity Liquidity • Liquidity coverage ratioand maturity mismatch Liquidity • Net stable funding ratio
Table 2: Classification of “green” macroprudential instruments.
Capital requirement. Recently, the so-called “green supporting factors” (GSF)
have been advocated to overcome the green finance gap. Among the supporters, there
are the European Commission (Dombrovskis, 2017), the High-Level Expert Group on
Sustainable Finance (HLEG, 2018), and the European Bank Association (EBA, 2018).
They emphasize the need to adjust banks capital requirements with green finance goals
by introducing a GSF, that is deemed useful to incentivize lending to green sectors, thus
promoting green investments. Opponents, however, express their skepticism considering
the experience with the GSF prototype, i.e., the small and medium enterprise supporting
factor (EBA, 2016), and hence the possible negative impact of GSF on bank stability
(Matikainen, 2017; Finance Watch, 2018).
The proposed mechanism is meant to affect banks’ ability to create credit and implies
adjusting the minimum capital adequacy requirement (CAR); i.e., the ratio required by
the regulator of a bank’s capital over its risk-weighted assets. Although the effectiveness of
(standard) CAR was highly debated in academic literature (Gauthier et al., 2012; Gersbach
and Rochet, 2017), its potential to affect the lending capacity of financial institutions is
largely supported by evidence (Aiyar et al., 2014; Budnik and Kleibl, 2018).
In the combined implementation of minimum capital requirement and GSF, banks
could calibrate the risk-weighted capital ratios so that low-carbon activities would exert
a lower pressure on their balance sheet and, therefore incentivize them to finance climate-
related projects. The de-risking of green assets is particularly relevant in a credit risk
measurement mechanism of risk-weighted assets, considering that, due to their longer
pay-back period, green projects are usually assigned higher (compared to brown assets)
risks weights. Considering the above-mentioned, the factor is applied on the denominator
10
Figure 4: The diffusion of green macroprudential instruments. Source: Authors’ elaboration basedon the ”Green Macroprudential Index” computed according to the data contained in (D’Orazioand Popoyan, 2018).
11
of banks’ minimum CAR as follows:
CARtgreen =
Et
RWAt=
Et
αbLbt + (αg − αGSF )L
gt
≥ β, (1)
where Et is the bank’s capital, RWAt is bank’s risk-weighted assets, αbLbt and αgL
gt are
respectively the brown and the green risk-weighted loans portfolios, and β is the CAR
set by the regulator. αGSF is a mark-down on a green loan risk-weight; it affects the
capital requirement imposed on banks by altering the risk-weight of the asset depending
on whether it is identified to be green or brown (HLEG, 2018; EBF, 2018), according
to the criteria discussed in Section 2. From this definition it follows that if the bank is
identified to be “brown”, then αGSF = 0, otherwise αGSF > 0 and αGSF < αg.
According to us, the policy direction is right; however, the way it is approached can
undermine its effectiveness and have destabilizing effects for the banking sector. First, the
introduction of a GSF in the current stance implies looser regulatory CAR for green assets,
which underestimates possible real financial risks associated to them (Schoenmaker and
Van Tilburg, 2016; Matikainen et al., 2017; Van Lerven and Ryan-Collins, 2018). In our
view, a CAR-GSF cannot be efficiently implemented until a more risk-sensitive approach
is adopted. As discussed in Section 2, this will be based on the establishment of a common
taxonomy and disclosure standards for green assets, as well as mechanisms to transform
climate exposures (measured by carbon intensity) into credit risk and a creditworthiness
indicator. Additionally, acknowledging that if we consider carbon-intensive assets as highly
risky does not automatically imply that green assets are safer, the implementation of a
GFS should be conceived together with the set up of a targeted loan-loss reserve which
could be able to absorb the risk that cannot be backed-up by regulatory capital. Second,
as pointed out by 2DII (2018), the GSF would have an overall limited effect if compared to
the small and medium enterprise supporting factor, even under an expanded application
of the factor. According to the report, the total capital savings related to the introduction
of the GSF would be of 2-4e billion, or 5-8e billion under an expanded definition. These
amounts are however lower than the estimated 12e billion for the small and medium
enterprise supporting factor (EBA, 2016).
Considering the arguments mentioned above, a stronger case in favor of a “brown-
penalizing factor” (BPF) emerges, as highlighted by 2DII (2018) and Villeroy de Galhau
(2018). While the GSF would lower the capital requirement for green credit with no proved
evidence that green assets are actually less risky (Moody’s, 2018), the BPF would require
banks to hold more prudential capital for carbon-intensive assets (add-on factor). Worth
mentioning that a sustainability taxonomy would still be first required before the applica-
tion of BPF. Furthermore, adopting this perspective, it implies that banks would become
more risk-sensitive regarding brown assets and they would hold more loss-absorbing capital
to withstand a possible carbon bubble or a probable repricing of stranded assets.
12
According to us, by adopting this definition of green capital requirement, policymakers
would be more likely to avoid risk underestimation, consequently providing a more robust,
and less risky, regulatory capital framework for the banking sector.
Differentiated reserve requirements (DRR). Among the instruments that could
be implemented to aligning low-carbon transition and financial stability objectives, differ-
entiated “green” reserve requirements are drawing particular attention (Rozenberg et al.,
2013; Campiglio, 2016; Volz, 2017).
Reserve requirements are a central bank regulation employed by most central banks;
it sets the minimum amount of reserves that must be held by a commercial bank as a
counterpart to customer deposits and notes. They are used, in addition to their open-
market operations, to control money supply.
DRR explicitly target financial institutions actively involved in the green transition by
easing the reserve requirement (RR). The level of DRR depends on the composition on the
bank’s portfolio and may be reduced in proportion of the bank’s lending to green sectors,
thus subsidizing green credit. In contrast to the existing harmonized RRs, the green RR
would allow banks to hold fewer reserves against a “green” loan portfolio. By directly
affecting the bank’s money-creating ability, it would therefore align the profitability of
their lending activities with the climate policy target.
Several central banks and regulators have already implemented both multiple (de-
pending on a banks size, type, and maturity of liability, currency, etc.) and differentiated
(depending on the targeted sector) RRs aimed at steering credit to specified financial in-
stitutions and areas of the economy. China offers a pertinent example of a country using
multiple and DRRs as a regular policy tool (Fungacova et al., 2016; Chang et al., 2018).
Another example is the Central Bank of Lebanon that, since 2010, supports green credits
by lowering the RR of commercial banks by 100-150% of the loan value in the case in
which bank can provide a certificate of energy savings potential of the financial project
(BDL, 2009, 2010).
A possible implementation of the DRR is suggested in the following, by pointing out
that before its direct application, a calibration of a green factor, σ, is necessary.
Rt = σ ∗Dt, (2)
where Dt is the stock of deposits hold by the bank at period t and σ is a fraction of
attracted deposits to be kept as a reserve; it allows us to distinguish between “green” and
“brown” banks, so that σ ∈ {σbrown;σgreen}. When distinguishing between banks with
“green” and “brown” loan portfolios the following holds: 0 < σgreen < σbrown, where σgreen
depends on country-specific factors (discussed below), the presence of other macropruden-
tial instruments, the monetary policy stance and declines with increased green taxonomy.
13
The implementation and efficiency of the DRR depend on the policy frame it serves
for (i.e.; monetary, macroprudential, microprudential), and country’s characteristics. In
the following, we will distinguish between the perspective of developing and developed
countries. Before proceeding with our discussion, it is important to note that we con-
sider the RR to be a monetary policy tool when it is used to regulate market liquidity,
a macroprudential tool when it is used to corrected the business cycle, and a micropru-
dential tool in the remaining cases. Indeed, when they were first implemented, RR were
designed for monetary policy purpose, but as emphasized by Cordella et al. (2014), they
have been intensively used by emerging economies as a countercyclical macroprudential
instrument. For example, in their analysis for the period 1970-2011, Federico et al. (2014)
find that 62% of the sampled countries followed an active RR policy; 2/3 were low-income
countries, 1/3 were high-income countries. Moreover, authors note that after 2004 none
of major low-income countries were involved in active RR policy. The rationale for the
noted differences is threefold. First, low-income countries are usually characterized by un-
developed financial markets, which may limit the efficiency of market-based instruments.
Second, their monetary policy is procyclical, due to the need of either defending the local
currency in bad times or not attracting more capital inflows in good times. This often
implies the need of a countercyclical (prudential) tool (Federico et al., 2014; Cordella et al.,
2014; Cerutti et al., 2016). Third, the procyclical behavior of the exchange rate over the
business cycle also plays a role. In the presence of open capital flows, the procyclicality of
the interest rate constrains the smooth conduct of monetary policy and the use of interest
rates as a countercyclical instrument. Therefore, in this framework, RRs are used for
stabilizing capital flows and the credit cycle, considering the existing limits on the typical
monetary policy ability to smooth the level of credit and/or economic activity (Cordella
et al., 2014).
Considering the peculiar framework of low-income countries and the countercyclical
use of RRs, i.e., rising it in good times and lowering it in bad times, as substitutes of a
procyclical monetary policy, the “green” RR is expected to have overall ambiguous effect.
Indeed, although they are designed to stimulate green investments, RRs are still a form
of liquidity requirement against the unexpected withdrawal of funds. Consequently, using
them to directly subsidize credit for green investments can hinder liquidity management,
thus bringing to a suboptimal outcome (Gray, 2011). Additionally, we point out that the
use of “green” RR in low-income countries characterized by “fear of capital inflows” and
“fear of free falling” behavior, may induce policymakers not to raise interest rates in good
times and use higher RRs to cool down the economy, which will bring distortions in either
monetary policy conduct or to the green loans flow. Hence more coordination among the
harmonized RR (which partially takes the role of monetary policy), the exchange rate
policy and green RR is needed in low-income countries.
In the case of high-income countries, instead, the efficiency of “green” RR can be
14
questioned under the abundance of liquidity in the money market after the post-crisis
“new normal” (e.g., quantitative easing, and the capacity of the reserve ratio to act as
a constraint on banks’ reserve of exposures (see Campiglio, 2016)). Being passive users
of RR both for monetary policy purposes (due to colossal central bank’s balance sheet
and excess liquidity in the market), and for macroprudential stance (under Basel III, the
focus is more on liquidity requirements than on reserve ratios), the efficiency of green RR
can be found in use with a microprudential option. In fact, as highlighted by Federico
et al. (2014), the majority of high-income countries in their dataset have zero legal reserve
requirements.
Countercyclical capital buffer (CCyB). CCyBs are designed to reinforce finan-
cial institutions defenses against the build-up of systemic vulnerabilities and serve as a
cushion during the contractionary phase of a credit cycle (Drehmann and Gambacorta,
2012; Jimenez et al., 2017; Popoyan et al., 2017). Their use is reported to have increased
after the global financial crisis (Budnik and Kleibl, 2018), while the literature on its actual
activation is scarce (BCBS, 2018) and there is a lack of evidence about its effectiveness
(Cerutti et al., 2017; BCBS, 2017).
Considering these features, we suggest that CCyBs can be used to favor financial
stability in the transition process from the high-carbon to the low-carbon economy. The
mechanism is shown in Figure 5. According to this proposal, building a buffer, i.e., a high
capital base, during periods of excessive carbon-intensive credit growth will increase the
bank’s resilience during the upswing of the carbon-intensive credit cycle acting as “soft”
speed limit, thus contributing to the “soft landing”. In this way, the CCyB could play an
important role in mitigating and preventing excessive credit growth and leverage related
to carbon-intensive assets. The buffer add-on contains ex-ante the risk of carbon-intensive
credit growth, thus helping building buffers to absorb ex-post shocks to high-carbon loans
(e.g., stranded assets), therefore ensuring a smooth transition process. Thanks to this
mechanism, we maintain that CCyB can favor financial stability by having a more direct
impact on brown assets and by exerting an important signaling power in the financial
market. However, for the CCyB to be effective, an adequate calibration (i.e., the % of
a banks total exposures) and early activation (i.e., implement before the cycle changes
the phase) are required. Beside level and timing issues, the implementation of the CCyB
depends on how banks adjust their capital ratios (BCBS, 2018), as well as on the measure
and indicators of climate-related systemic risk, which, as highlighted in previous sections,
is a relevant topic of recent research agenda (see Battiston et al., 2017).
15
Time
Carbon-intensive credit cycle without buffer
Carbon-intensive credit cycle with buffer
Buffer add-on Release of buffer
Figure 5: The buffer mechanism over the carbon-intesive credit cycle.
Another way to approach the CCyB could be the application of a negative capital buffer
(NCB) in addition to the “green” capital requirement. The NCB would allow for a reduced
level of the required minimum bank capital in case in which the bank’s credit portfolio
appears to be “green enough”. Additionally, the NCB can be considered a “compensation”
for banks that are not excessively exposed to carbon-intensive industry, or for their active
participation in the “green transformation”. As for the application of NCB, as in case
of GSF, targeted loss-reserves are needed to absorb uncovered and underestimated credit
risk while creating an incentivizing mechanism for the green transition.
Sectoral leverage ratio (SLR). While the leverage ratio in Basel III prevents
excessive on- and off-balance sheet leverage by defining a non-risk based capital limit in
terms of the ratio between bank’s equity and total exposures (BCBS, 2014), the SLR
hereby proposed could limit an overleveraged position to a targeted group of assets. The
underlying logic can be formally expressed as follows:
LRSectort =
Tier 1 Capital
Exposures to carbon-intensive sector≥ γ, (3)
where Tier 1 Capital is the bank’s core capital composed of common equity and retained
earnings; γ is the leverage ratio set by the regulator.
The relevance of the proposed SLR for financial stability depends on the extent to which
highly leveraged financial institutions are exposed to carbon-intensive assets. Therefore,
for a better calibration of the leverage ratio, banks’ exposure data, as well as the level of
carbon intensity of firms’ resources, should be adequately disclosed.
The impact the sectoral leverage ratio will have on banks’ incentives is similar to
16
the maximum credit ceiling (discussed below), but different regarding the balance sheet
structure. Whereas the credit floor caeteris paribus will stabilize a predetermined fraction
of the assets’ portfolio to be allocated to a particular type of assets, in case of the SLR
those assets will need to be backed-up by the bank’s equity. Moreover, as confirmed by
regulatory design and its effects (see BCBS, 2014a), the leverage ratio will serve as a
backstop to a risk-based capital requirement, to avoid the over-leveraging of a particular
sector and to keep the adequate capital base against certain groups of risky assets.
Liquidity regulation. The current liquidity requirement imposed by Basel III is
aimed at smoothing the maturity mismatch between assets and funding sources. The
two primary metrics of liquidity are the Liquidity Coverage Ratio (LCR) and the Net
Stable Funding Ratio (NSFR) (see Hong et al., 2014; Aldasoro and Faia, 2016; Bai et al.,
2018, on the efficiency of liquidity regulations). The former aims at “protecting” banks
against short-term liquidity crises; the latter constrains banks to fund long-term assets
with stable funding of at least one-year maturity. However, they may have unintended
consequences on green investment. First, LCR could reshuffle banks balance sheets toward
highly-quality liquid assets (e.g., cash, sovereign and central bank bonds that has 0% risk
weight, corporate bonds with high rating). Second, to meet the NSFR, banks will use
long-term funds (that are usually more costly) to finance long-term assets, which implies
that banks will cut the funding budget. In other words, banks will become more sensitive
to temporal mismatches between assets and funding, and hence more reluctant to hold
long-term assets (Liebreich and McCrone, 2013; Narbel, 2013; Spencer and Stevenson,
2013; Liebreich and McCrone, 2013). As a result, Basel III liquidity rules are likely to
make long-term financing more expensive, which will particularly affect “patient” (i.e.,
long-term) green investments, and they will likely limit the amount of capital available for
such financing.
Considering the issues raised above, to align this tool with the “green” objective, we
share the view expressed by the European Banking Federation (EBF, 2018). It proposes
the introduction of a precise incentive mechanism for the LCR and the NSFR requirements
to link the climate-related targets and the liquidity/maturity mismatch requirements in
the existing macroprudential setup. The introduction of a lower required stable funding
(RSF) factor (η) is considered as promising, under certain conditions, to identify green
exposures. We formalize it as follows:
NSFRt =ASFt
RSFt=
∑n φEEt +∑n φLiabLiabt∑m φBBt +
∑m φGGt≥ η, (4)
where ASFt and RSFt stand for available stable funding (ASF) and required stable
funding (RSF) respectively. In particular, ASF is composed of Liabilities (Liabt) and
Capital (Et) while RSF contains the brown (Bt) and green (Gt) exposure portfolios. Each
17
item in the balance sheet included in ASF and RSF is weighed with a factor imposed
by regulator: φE and φLiab for equity and liability, and φB and φG for brown and green
exposures respectively. Considering how the nowadays requirement is designed, the green
exposures would exert elevated φG factor to compare with φB hence pushing a bank to
keep higher ASF. To avoid this carbon bias green long-term finance should be considered
as a category of promotional loans (both for NSFR and LCR) and treated with the reduced
required stable funding (RSF) factor (i.e. for the same maturity assets φG = φB − μ <
φB, 0 < μ < φB).
Minimum credit floors and maximum credit ceilings. Although they were
heavily criticized due to their non-market based nature, maximum credit limits have been
widely used in advanced economies after the recent financial crisis to limit bank exposures
to certain type of sectors’ activities and loans’ categories (see Lim et al., 2011; Van den
End, 2016).10
As emphasized by Volz (2017), they offer a very straightforward mechanism to channel
investments to “green” projects. Maximum credit ceilings to certain carbon-intensive or
polluting activities (sectors), or alternatively minimum credit floors, that require banks to
allocate a predefined fraction of their loans’ portfolio to a “green” sector, are thus worth
considering for the aim of closing the green finance gap. In contrast to a maximum credit
ceiling (Farahbaksh and Sensenbrenner, 1996), which creates incentives for banks to limit
lending to less sustainable sectors, the minimum credit floor is a “hard” limit set by the
regulatory authority.
Large exposure limit. The large exposures limit is aimed at containing the maxi-
mum possible losses a bank could incur in the case of a failure of a single counterpart or a
connected group of counterpart, to a level that does not compromise the bank’s solvency.
It complements the Basel’s risk-based capital standard because the latter is not designed
specifically to protect banks from large losses resulting from the sudden default of a single
counterparty (BCBS, 2014b).
When applied for low-carbon transition purposes, the exposure limit could, on one
hand, limit banks’ overexposed position towards counterparts with highly carbon-intensive
assets; on the other hand, act in a macroprudential manner to safeguard the banks during
the transition and from systemic risks. This tool, therefore, contains an allocative feature
very similar to credit ceilings with a difference that credit ceiling points a group or a type
of assets, while Large exposure limit relies on the identification of counterpart (s) with high
10Note that minimum credit floors and maximum credit ceilings were used much before the financialcrisis as a classical instrument for credit policy. In post-crisis era time-varying Minimum credit floors andmaximum credit ceilings they were classified as macroprudential instruments to be adjusted through thecredit and leverage cycle (see Claessens, 2014, for more details).
18
participation in carbon-intensive activities and limits the exposures of the banks towards
the latter.
As emphasized by Schoenmaker and Van Tilburg (2016), credit limits could be the
most appropriate regulatory instrument to deal with material climate-related risks. Their
implementation implies, however, a high effort on disclosing and reporting every large
exposure connected to a single, group or interconnected carbon-intensive firms. For an
effective implementation, two further steps are thus required. The first suggests a precise
definition of what large exposures to the carbon-intensive sector is. For example, large
exposures to carbon-intensive sectors could be defined as carbon-intensive exposures to
clients or groups of connected clients where the value of it is equal, or exceeds, certain
percentage (defined by regulator) of the eligible capital of the bank. The ratio of exposures
to eligible capital to indicate the large exposure could be calibrated considering the country
characteristics, the concentration of carbon-intensive firms, the presence of other stringent
requirements, etc. The second implies a definition of the maximum large exposure limit
itself to a single counterparty, or a group of connected counterparties, which has not to
be higher than a certain percentage of bank’s regulatory capital base.
19
20
21
Figure 6: Green macroprudential instruments: overview of their policy implications and alternative measures.
22
4 Conclusions
By looking at the current financial framework, financial risks related to physical, liabil-
ity and transition risks do not seem to be adequately considered by financial institutions
nor by regulators and markets. The attention is usually devoted to the causal relation
that goes from the green transition process to the financial sector, while the effects of
monetary and macroprudential policies on the so-called green structural change are often
overlooked. Taking into account the climate-related financial risks and the need to fill the
green finance gap, in the paper, we argue that prudential authorities can play a potentially
important role in leading the transition to a low-carbon economy.
To support our claim, we have examined the existing and novel prudential approaches
to incentivize the decarbonization of banks’ balance sheets and promote green investments.
Moreover, we have critically discussed their pros & cons in channeling the financial flows
to sustain a smooth transition, while reducing the systemic risk and the procyclicality of
the financial sector.
Additionally, we have reviewed official central banks documents to provide an up-to-
date mapping of green prudential regulations and tools currently available at the OECD,
low-income countries and European level. Because of the variety of institutional arrange-
ments and forms of cooperation among central banks, commercial banks and government
that can be distinguished theoretically, there does not exist a “one-size-fits-all” approach
to greening the financial system, because path-dependencies and the peculiarity of na-
tional institutional frameworks play a crucial role in the process of change that is needed
to achieve a greener economy.
Regarding the adoption of green macroprudential tools, an interesting heterogeneous
picture emerges from our analysis. While many low-income countries are adopting manda-
tory prudential instruments to channel credit towards green sectors, high-income countries
seem to lag behind by staying still satisfied by an “all talk, no walk” strategy.
According to our investigation, while policymakers are increasingly contributing to the
development of a green macroprudential regulation, many existing policy intervention and
proposals are prone to destabilizing effects for the financial sector. We thus suggest a
set of alternative strategies to greening the existing Basel III. Among them, we suggest
to adopt a countercyclical (or negative) capital buffer along the carbon-intensive credit
cycle, a sectoral leverage requirement which targets exposures toward a specific green sec-
tor, a liquidity regulation to dampen short-termism in financial intermediation, minimum
(maximum) credit floors (ceilings) and large exposure limit to constrain an intermediary
exposure to brown sectors. In particular, in the case of the establishment of a minimum
capital requirement with Green Supporting Factor, we suggest two alternatives. In our
view, it would be necessary to either adopt a more risk-sensitive capital requirement, with
the GSF based on a common taxonomy and disclosure standards for green assets, combined
23
with implementations of loan-loss reserves or rather opt for a Brown Penalising Factor.
Regarding the application of DRR as a possible green macroprudential instrument, we see
it more suitable for low-income countries rather than high-income countries, where the
legal reserve requirements are close to zero. We also point out that it can hinder liquid-
ity management, bringing to a suboptimal outcome and tangle the conduct of monetary
policy; hence, a strong coordination issue arises.
Moreover, although the empirical evidence on the effectiveness of the standard macro-
prudential tools is still scarce, and the quantitative approach is of limited guidance for
the calibration of green macroprudential tools, we suggest that these instruments could
play an important role. However, according to us, the current harmonized Basel III
financial regulatory setup can be used to align climate and financial stability objectives.
This implies on one side, the set up of a commonly defined taxonomy of environmentally
sustainable economic activities and an agreed-upon disclosure framework, on the other
side, some degree of experimentation left for policymakers and regulators, in an attempt
to strike a balance between “boldness and realism” (Borio, 2011). We think, indeed, that
although it exists the risk to attribute overly-ambitious goals to central banks, the window
of opportunity offered by the proposed green policy framework to tackle climate change
cannot be missed. As the financial crisis has to lead to the build-up of instruments to
ensure the system’s resilience against financial instability, we envisage a similar dynamic
for the development of green prudential instruments to tame financial risks related to
physical, transition and liability risks, and contribute to increase the financial resources
to be devoted to green investments.
Acknowledgements
The authors are grateful for helpful comments to two anonymous reviewers. They thank
also Susanna Calimani, Emanuele Campiglio, Giorgios Galanis, Francesco Lamperti, Irene
Monasterolo, Luca Nocciola, Michael Roos and Marco Valente for comments and discus-
sions on an earlier version of the paper. The participants of the Conference on Financial
Networks and Sustainability, FINEXUS 2018 (Zurich, Switzerland), the International Fi-
nance and Banking Society Conference, IFABS 2018 (Porto, Portugal), the Forum for
Macroeconomics and Macroeconomic Policies Conference 2018 (Berlin, Germany), the
workshop “Scaling up Green Finance: The Role of Central Banks” (Deutsche Bundesbank
and Cepweb, Berlin, Germany) are also acknowledged for their very useful comments. Lilit
Popoyan acknowledges the support by European Union Horizon 2020 grant: No. 640772
- Project Dolfins. The usual disclaimer applies.
24
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A Macroprudential tools under Basel II and Basel III
BASEL II
Pillar I Pillar II Pillar III
Minimum capital Supervisory review Market discipline
requirement
Minimum standards for - Capital adequacy Risk management:
management of capital: strategies • credit
• Credit risk - Evaluation internal models • operational
• Operational risk - Level of capital charge • market
• Market risk - Proactive monitoring of
capital levels and ensuing
remedial action
BASEL III
Pillar I Pillar II Pillar III
Enhanced minimum capital Enhanced Enhanced risk disclosure &
& liquidity requirements supervisory review market discipline
Additional tools: Additional tools: Additional tools:
- Liquidity coverage ratio (LCR) - ICAAP - Regulatory capital components
- Net Stable Funding Ratio (NSFR) - Supervisory review - Regulatory capital ratios
- Leverage ratio Evaluation process - Securitisation exposures
- Capital conservation buffers - Stress tests
- Countercyclical capital buffers
- Enhanced loss absorption clause
- Quality and level of capital
- Securitization
- Trading risk
- Counterparty credit risk
Table 3: Overview and comparison of the 3 Pillars framework of Basel II (upper panel) and BaselIII (lower panel).
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B Focus on Europe
Figure 7: The diffusion of green prudential instruments: an European perspective
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C Focus on Asia
Figure 8: The diffusion of green prudential instruments: an Asian perspective
35